Apple plays with fire, courts iPhone gift card lawsuits

Apple's recent decision to forbid the use of Apple Store gift cards for iPhone sales may expose the company to class action lawsuits or state-led investigations. Is this anti-iPhone locking action one step too far for the company?

Apple set the blogosphere on fire Monday when word leaked of the company's latest effort to limit iPhone unlocking. Recent media reports reveal that that the company has instituted a two-device-per-visit limit for iPhone purchases and has banned the use of cash for such transactions. However, the latest news indicates that Apple is now also banning the use of Apple Gift Cards for iPhone sales. Wired News confirmed the rumoron Monday afternoon. A representative from the Burlingame, Calif., Apple store told Wired News that "official" policy is now that gift cards will not be accepted for the sale of iPhones.

Before we get into the nitty gritty of this incident, lets step back and explore exactly how Apple describes the gift cards on its Web site:

Apple Gift Cards
Apple

"An Apple Gift Card lets you take the guesswork out of gift-giving. Your friends and family can choose exactly what they want from any retail Apple Store, from the online Apple Store, or by calling 1-800-MY-APPLE in the United States."

Also...

"You can purchase just about anything sold by Apple (except another Apple Gift Card, an iTunes Gift Certificate or purchases at the iTunes Music Store), including products from both Apple and third-party makers."

There does not appear to be any small print on the gift card program Web site stating that Apple reserves the right to reject gift cards for any purchase or change the terms and conditions after the fact.

On Monday afternoon, I spoke with Professor Avery W. Katz, vice dean
and Milton Handler Professor of Law at Columbia Law School. Katz
regularly teaches classes in contracts, secured transactions, and payment systems.

When asked if he had heard of any other companies refusing to take
their own store gift cards in the past, Katz replied that "(this is) a
new one to me," and that he believes that "most customers will be
surprised to learn that their gift cards will not be accepted" for the
purchase of items from a company's official store.

Professor Katz noted that even if Apple's gift cards were covered by a
small-print or shrink-wrap contract, "in the case of a consumer
purchase, not everything in the fine print of a consumer contract is
enforceable. This area is one of some controversy in contract law." In
general, he said, "the enforceability of these fine-print terms
depends on how reasonable the fine print is and what a consumer can
reasonably expect of the sale."

Katz also confirmed that the courts did not expect consumers to have
legal counsel read the terms of a gift card before they buy it in the
store. He further noted that different states' laws apply, and in
particular that some states' laws are far more pro-consumer than
others.

Katz was not willing to speculate on the legal options available to
consumers who purchased Apple Gift Cards and were no longer able to use
them to buy iPhones. However, he did confirm that consumers have much
stronger level of protection in cases where the gift cards were
purchased with credit cards as opposed to cases where the gift cards
were purchased with cash. In such cases, consumers have the right of
"chargeback," in which they can dispute the purchase when they are not
happy with the goods (in the event the item is defective, for example,
or if a gift card is not redeemable in the way that the consumer believed it to be at time of sale).

Protesters show Apple some anti-DRM love
quinnums / flickr

I also spoke to Russ Heimerich, a spokesperson for the California Department of Consumer Affairs. California has specific civil laws that relate to the sale and use of gift cards, although they mainly relate to expiration dates, fees, and the ability of consumers to get cash refunds for low amounts of trapped funds. Consumers who purchased gift cards with the intention of using them to buy iPhones should, Heimerich said, go back to the Apple store and ask for a refund. When asked about the legality of what some might consider to be a bait and switch by Apple, Heimerich said that "(the situation) doesn't sound right to me," and referred me to the California Attorney General's office, which has not yet returned my calls. Calls made to Apple have also yet to be returned.

Apple is no stranger to class action lawsuits. With respect to the current gift card issue, the company has sold the cards to consumers stating that consumers can use the gift cards to purchase "exactly what they want from any retail Apple Store." And now, once people have given the company money, Apple has decided to no longer accept lawfully purchased gift cards for one of the most popular items it sells. I'm no gambling man, but if Apple doesn't see a lawsuit or attorney general investigation into this incident in the next six months, I'll sell my open-source Linux-based Nokia N800, and buy an iPhone.

According to The New York Times, analysis of Apple's recent financial statements indicates that the company receives up to $18 per customer per month from AT&T. Over the life of a two-year contract, Apple stands to earn up to $432. Add in the cost of the iPhone device itself, and Apple earns more than $830 from every iPhone customer who signs up for an AT&T contract. Compare this to the cost of the physical components that go into the iPhone, which was reported to be $220 back in July of this year, and it's clear that the iPhone is a gold mine.

There seems to be some uncertainty among commentators and even some legislators over the iPhone. Let's get one thing straight: the iPhone is subsidized. The fact that Apple makes almost $200 profit on every iPhone sold is irrelevant. Apple sells the iPhone for less than its expected profit from the device with the expectation that the other $400 will come from its profit-sharing agreement with AT&T. Customers who buy the phone, unlock it, and use it with T-Mobile or an international carrier are denying Apple the funds that it expected to receive.

With more than 250,000 iPhones sold since June 29 without being activated on AT&T's network (phones most likely unlocked and used elsewhere), Apple has been denied subscriber-generated profit of more than $100 million. Thus, it's not too difficult to see why Apple "unintentionally" turned unlocked iPhones into bricks and then, most recently, limited the sale of iPhones to two per customer and banned cash and gift card transactions. The company doesn't want people buying the phones, unlocking them, and then reselling them, either in the U.S. or in even more-profitable foreign markets.

Now, lets take a deeper look at the issues at play here. In particular, which other companies try to limit the number of devices that customers can purchase?

In August 2006, three Arab-American men were arrested in Michigan; the men had in their possession more than 1,000 prepaid mobile phones, most of which had been purchased at Wal-Mart stores around the state. Local prosecutors initially charged them with collecting or providing materials for terrorist acts, although these charges were later dropped. The three men from Michigan were engaged in a modified form of arbitrage: they bought heavily subsidized devices, removed the software, and resold them to consumers wishing to use them on other networks. Tracfone, the company whose telephones the men had purchased, claims that it is losing millions of dollars a year from the practice.

That's right--Apple has now adopted the same tactics as Tracfone, a prepaid-phone company that targets low-income consumers who do not have the credit necessary to enter into a contract.

I've written about Tracphone's troubles, as well as the more general problems faced by other companies in similar markets, in a new research paper Caveat Venditor: Technologically Protected Subsidized Goods and the Customers Who Hack Them, which will be published later this fall in the Northwestern Journal of Technology and Intellectual Property. While I recommend that you read my paper, the take-home lesson from it is that by not giving consumers a non-locked iPhone (albeit at a higher price in order to make up for the lack of AT&T profit sharing), Apple is only inviting hackers and tinkerers. For those of you who claim that the iPod Touch is just this: remember that only the iPhone has a camera and Bluetooth, which are essential features for anyone wants to create VoIP and videoconferencing software for the device.

Apple has fought (and lost, thankfully) a very public legal battle against the right of bloggers to remain anonymous. Thanks to its its trigger-happy legal department, it has made lifelong enemies of a number of security researchers. Now, over the space of just a few years, the company has gone from a much-loved underdog in the personal-computer space to the DRM-loving 800-pound gorilla of the online music business, and now has adopted the tactics of low-end prepaid phone companies whose products are sold at 7-Eleven.